Following the backlash against managed care and faced with a sharp rise in health care costs this year, employers are searching for a new cure to spiraling health care premiums.


Many are considering a model based on the notion of self-directed care, in which employers set aside a certain amount of money for their workers’ health coverage, then let each employee have a say in how best to spend it.


Some health-care economists argue this type of plan closes the historic disconnect between the payer and user of health care services and will lead to more effective health-care spending and lower costs. Critics, however, contend these plans can punish those who are sickest and encourage consumers to pinch pennies on prevention and risk serious illness later.


Mark V. Pauly, an economist and chairman of Wharton’s health care systems department, said an underlying problem with health care coverage is “it makes something that is expensive seem cheap.” He said the concept behind the new consumer-directed plans has been around in various forms for years, but faded in the 1990s when the focus on cost containment turned to managed care.


Adds Wharton health care professor Sean Nicholson: “Now that the economy is not so strong and premiums are going way up, people are looking for the new magic bullet.” Under a typical self-directed plan, Nicholson said, a company might place $2,000 a year in an employee’s personal spending account and then purchase a catastrophic health insurance plan for the employee. The employee uses the money from the personal spending account to pay for routine medical care such as physician office visits and prescription drugs. If the employee exhausts the personal account, that individual might pay out of his or her own pocket for the next $1,000 of medical care. Beyond that, the employee’s catastrophic plan kicks in. If part of the personal spending account goes unspent, it rolls over for the next year.


President Bush, in a major speech on February 11 outlining $300 billion in healthcare initiatives, called for the expansion of Medical Savings Accounts, of MSAs, which have been limited to self-employed workers or small businesses in a pilot program.

MSAs allow workers to combine a high deductible for catastrophic coverage with a special savings account to be used for routine medical costs. Under the current law, money set aside in the account, up to 65% of the deductible for singles and 75% for families, is excluded from gross income when paying taxes. Interest earned on the account is tax-free.


Bush said he wants to reduce MSA deductibles to levels common in employer-sponsored plans and allow MSA funds to be spent on preventive care. His proposal, he added, would allow more people to set up MSAs for out-of-pocket expenses.


The president also proposed a change in Flexible Savings Accounts for people in employer health plans that would allow them to roll over up to $500 in unspent healthcare funds into their FSA account for the following year or into a 401(k) retirement account. Currently, funds set aside must be used in the same year or are lost. The White House estimates that these two changes to health care savings accounts will cost taxpayers $14 billion over the new 10 years.


Another form of self-directed coverage is a defined contribution plan in which an employer sets aside a certain amount for each employee’s premium, then gives workers a choice of plans. “The difference between MSAs and defined contribution plans is that with an MSA you put money aside into a savings plan, but it is still your money. There is not a pooling of risk across individuals. It’s not really an insurance product,” said Patricia Danzon, Wharton professor of health care systems and insurance and risk management.


Danzon said insurance generally works best when it protects people against major expenses, but leaves them to pay minor or routine costs. However, she added, this becomes tricky in the area of drug coverage in which routine medications for chronic conditions can add up to an enormous expense. “The purpose of insurance is to provide consumers with financial protection so they don’t face the full cost. The challenge is to find a form of insurance that gives them the best balance between paying out-of-pocket and offering them complete protection. There’s no perfect solution; it’s always going to be a balance.”


A leading provider of the new self-directed plans is Definity Health of Minneapolis, which began offering the plans a year ago and now has 22 companies enrolled. It is currently negotiating with 100 more companies which want to offer the plan next year, said Chris Delaney, a spokesman for Definity.


“Our success is heavily dependent on the consumer being involved in his or her health care choices,” said Delaney. In the first year the plan has cut costs primarily through the use of over-the-counter medications instead of prescription drugs for colds and allergies and through expanded use of a telephone nurse advisory system.


According to Delaney, Definity clients overall saw a drop of more than 10% in their employees’ use of medical care last year. The company is now examining data to quantify whether their patients were any sicker as a result. But Delaney said Definity plan members, on average, did not use critical medications, such as heart or asthma drugs, any less than patients who are not in the plan.


A key to the self-directed plans is computer technology that allows plans to let members know the prices of procedures they might need and information about the quality of services received from a hospital or doctor.


Another Minneapolis company, Vivius, has a software package that allows employees to construct their own benefit package plugging in doctors’ fees and other expenses. The patient becomes a “general contractor,” said Nicholson. “The people who play up self-directed care say, ‘Look at the Internet; we no longer have a naive consumer.’”


According to Nicholson, the new wrinkle in Definity’s plan is that it allows employees to keep any medical dollars they don’t spend by the end of the year by rolling the balance into the personal spending account for the following year. That, he said, gives employees a true incentive to save, rather than rush out and buy a new pair of eyeglasses at the end of December because the benefit is about to expire. “That’s how you are going to get employees thinking carefully about what they are spending their money on because it’s real money.”


Nicholson also predicted, however, that there may be tax problems in allowing employees to roll over a balance from one year to the next. In addition, he pointed out, employers may be reluctant to sign on with defined contribution plans because it gives them less flexibility to tinker with their overall cost structure. Now, if health insurers raise the premium, an employer can reduce or eliminate benefits (e.g. raise the deductible) to mitigate the premium increase the workers face. A self-directed plan, he said, “is more naked. You’ll be able to see what the employer is putting in and if the employer’s contribution is decreasing over time.”


Research simulations show the plans may also create adverse selection in the insurance market, in which healthy consumers opt for the self-directed plans because they are less expensive for people who are light users of the health care system, leaving the burden of sicker employees on traditional plans, said Nicholson. “Then all the plans that lost the healthy people will raise the premium.”


That is the fear of consumer advocates as well. Gail Shearer, director of health policy analysis at Consumers Union in Washington, D.C., said self-directed plans will skim off the healthiest employees leaving those with pre-existing conditions or other health risks to pay a far greater share of their medical expenses than if the costs were pooled among a larger group of workers. “This is on the agenda because of the cost pressure but the reality of the marketplace is that consumers don’t like it,” said Shearer.


A survey of employers by Hewitt Associates, the benefits consulting company, found that two-thirds of employers were interested in considering greater employee involvement in health care. “In the next five years you will see employers and employees moving in that direction … the employer will become a bridge to a system later on where there is even more independence for consumers,” said Frank McArdle, managing principal of Hewitt’s Washington D.C. research office.


Wharton’s Pauly suggests that reconfiguring plans does not necessarily enhance employers’ profits or employee morale. “If the employees would have preferred a decent raise over a complicated health spending account, such reconfiguration could make things worse for the employer,” he noted. “And for employers under financial pressure, shifting medical care costs to employees will save an employer money, but that employer could just as well have preserved medical coverage but given lower raises,” an approach that employees might prefer.


At the moment, the notion of consumer-powered plans is talked about more among consultants and start-ups like Definity and Vivius than among the big insurers and corporate executives who must ultimately foot the bill, said Nicholson. “If these plans catch on, you will very quickly see the big insurers ready to offer their own versions along with their regular plans,” said Nicholson. “These days there’s a lot of  buzz about these [new options]. Now let’s see if employers actually offer them and if employees actually choose them.”